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RHEHNSC/NATIONAL SECURITY COUNCIL WASHDC
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UNCLAS SECTION 01 OF 03 SAO PAULO 000227 
 
STATE PASS USTR FOR KDUCKWORTH 
STATE PASS EXIMBANK 
STATE PASS OPIC FOR DMORONSE, NRIVERA, CMERVENNE 
DEPT OF TREASURY FOR JHOEK 
USDOC FOR 4332/ITA/MAC/WH/OLAC 
 
SIPDIS 
SENSITIVE 
 
E.O. 12958: N/A 
TAGS: ECON ELAB EIND EAGR ENRG KTDD EINV BR
SUBJECT: SOARING FOOD PRICES WOLDWIDE AND FOOD INFLATION IN BRAZIL 
 
 
SENSITIVE BUT UNCLASSIFIED--PLEASE TREAT ACCORDINGLY 
 
REF:  Sao Paulo 207 
 
¶1.  (SBU) SUMMARY: Brazil has suffered less from skyrocketing world 
food prices than other emerging markets.  As a net global food 
supplier, Brazil's agricultural exports earnings are climbing. 
However, rising global inflation - particularly higher oil prices, 
which affect both the cost of fertilizers and the costs of 
transportation - has spilled over into domestic prices, driving up 
inflation expectations, and forcing the Central Bank to raise 
interest rates.  This quick, anti-inflationary monetary policy and 
the net benefits that rising food prices have on Brazil's balance of 
payments mean that Brazil remains well-positioned to address 
near-term food inflation pressures.  In the medium term, Brazil does 
face some risk from food inflation via a potential decrease in 
long-term global demand for biofuels.  To the extent that rising 
food inflation affects global perceptions regarding biofuels, 
Brazil's longer-term economic outlook could be affected given its 
significant investments to develop and promote a global biofuels 
industry.  END SUMMARY. 
 
RISING FOOD INFLATION IN BRAZIL; THE ECONOMIC RISKS 
--------------------------------------------- ------- 
 
¶2.  (SBU) Rising food inflation poses four near-term economic risks 
for Brazil:  First and most immediately, it will intensify headline 
inflation and pressures on central banks to tighten monetary 
policies, especially those with inflation targets, such as Brazil. 
A second risk is a potential decline in fiscal discipline as 
governments expand subsidies or price controls in response to food 
inflation.  A third risk is balance of payments shocks for countries 
that are net food importers.  A final risk is an increase in trade 
protection.  Argentina, for example, has raised tariffs on food 
exports, a measure that has resulted in protests by farmers that 
could reduce local production and raise food prices there further. 
Other countries have banned food exports, a move also likely to 
restrict supplies and further pressure food prices.  Brazil has 
joined this group by stopping some rice exports in order to supply 
the domestic market with this important staple. 
 
¶3.  (SBU) In the near-term, food inflation (which is significantly 
tied to rising petroleum prices) has been a primary cause for higher 
headline inflation.  Over the past year, food prices have risen by 
12 percent in Brazil compared with a three percent increase in 
non-food prices and a 4.7 percent increase in the Consumer Price 
Index (CPI).  The price of soybeans showed the steepest increase, 
(126 percent) followed by meat, (23 percent) and bread (13 percent). 
 Food inflation will remain much higher than non-food inflation for 
the next year.  In the past year, the CPI rose 1.25 percent, while 
inflation expectations rose by more than 0.5 percentage point to 4.8 
percent over the past six months.  Concerned about rising inflation, 
the Brazilian Central Bank (BCB) recently began a tightening cycle 
and raised the benchmark Selic rate by 0.5 percentage points on 
April 16 to 11.75 percent.  Market forecasts for credit expansion 
and investment growth this year have been reduced accordingly. 
(Comment: S&P's move to upgrade Brazil to investment grade on April 
30 may revise expectations of investment growth upward and will be 
reported septel.  End Comment.)  According to Luiz Fernando 
Figueiredo of Maua Investments, the investment community expects two 
more interest rate hikes of 0.5 percentage points each between now 
and July.  There is little expectation that the current tightening 
cycle will result in rates rising more than 1.5 to two percentage 
points. 
 
¶4.  (SBU) While the medium-term impact from food inflation should be 
limited, there remain some areas of concern.  Biofuels have been 
increasingly blamed for the rising scarcity of global food supplies 
and the resulting rise in food prices.  As a result, Brazil and the 
U.S., the world's two largest ethanol producers, have been accused 
of exacerbating food inflation and pushing up to 100 million people 
closer to poverty, according to a World Bank estimate.  A prolonged 
cycle of food inflation and concerns about the rising social costs 
 
SAO PAULO 00000227  002 OF 003 
 
 
of biofuels could cause a permanent downward shift in some 
countries' demand for biofuels, especially in Europe.  However, the 
vast majority of ethanol is used for domestic consumption and that 
demand is growing rapidly (reftel).  Further, the largest share of 
ethanol exports go directly or indirectly to the United States, 
where demand for ethanol is likely to increase and which does not 
seem to be affected by the outcry over sustainability.  Overall, the 
impact on Brazilian exports should be small, but there remains the 
potential for the food versus fuel debate to hurt Brazilian exports, 
and undermine Brazilian economic and political investments in 
internationalizing the sector. 
 
BRAZIL SET TO WEATHER THE STORM? 
-------------------------------- 
 
¶5.  (SBU) Compared to many other countries, Brazil appears 
well-positioned to withstand near-term food price pressures.  This 
conclusion is based on the following factors: (1) Brazil's share of 
food consumption in household budgets is lower than in many other 
countries.  Food represents 21 percent of average household 
consumption in Brazil compared to higher shares in many other 
countries (over 50 percent in much of Africa and 70 percent in the 
world's poorest countries).  This more limited role will help to 
contain broader inflation spillovers and reduce Brazil's relative 
need for monetary tightening.  (2) The BCB is acting preemptively 
against rising inflation.  The decision last month to raise rates by 
0.5 percentage points was double the expected hike, and was the 
first of several hikes expected this year.  Recent Central Bank 
statements have been hawkish.  While tighter policy will slow 
near-term growth, it should decrease the risk that inflation could 
spiral upwards as well as help stabilize monetary policy over the 
medium-term.  In contrast, central banks in many other countries 
have reacted more slowly.  Several governments have responded by 
tightening price controls - a measure that will repress inflation in 
the short-run but risks a price spike once controls are lifted.  (3) 
Brazil's fiscal policy is more firmly anchored than many other 
countries.  Although Brazil does not have an explicit fiscal target, 
it maintains an informal primary surplus target of 3.8 percent of 
GDP that is closely watched by markets.  With GOB expenditures 
equivalent to roughly 40 percent of GDP, Brazil has little fiscal 
space in which to expand public spending.  (4) Brazil is a net food 
exporter and perhaps most importantly, Brazil's trade account 
benefits directly from higher food prices through improved 
terms-of-trade.  Food represents one-third of Brazilian exports and 
a large share of its overall trade surplus.  Major food exports 
include beef, chicken, soy, rice, sugar, orange juice, and coffee, 
all goods whose prices have risen.  Brazil's situation contrasts 
with most other developing countries, 70 percent of which are net 
food importers and whose external financing needs are increasing as 
a result of rising food prices. 
 
¶6.  (SBU) Nonetheless, Brazil does face some near-term challenges. 
For example, with 31 percent of Brazil's population below the 
national poverty line and one-third of its population suffering from 
"food insecurity", ever-present pressures exist to expand Brazil's 
social safety net.  Rising food prices could increase demands to 
raise public wages - an issue on which President Lula's government 
has a weak track record.  Faster wage growth could likely be paid 
for only through reductions in spending on the government's growth 
acceleration plan (PAC), slowing Brazil's future growth potential. 
 
COMMENT 
------- 
 
¶7.  (SBU) Brazil is well-positioned to cope with the near-term and 
mid-term effects of rising food inflation.  Monetary policy has 
responded quickly to rising prices, fiscal policy is well-anchored, 
and Brazil's current account balance benefits strongly from higher 
food prices.  There is a potential risk that food inflation may have 
a significant negative spillover into long-term global demand for 
Brazilian biofuels exports.  To the extent food inflation harms 
perceptions about the costs and benefits of biofuels, future demand 
for biofuels exports could wind up being somewhat flatter than is 
currently envisioned.  While not catastrophic for Brazil, this 
 
SAO PAULO 00000227  003 OF 003 
 
 
development is likely to hinder Brazil's ethanol industry from 
realizing the full growth, scale, and global stature to which Brazil 
aspires.  END COMMENT. 
 
¶8.  (U) This cable was written in conjunction with the Treasury 
Attache and was coordinated and cleared by the Embassy in Brasilia. 
 
WHITE